INVESTMENTS IN
PRE-IPO COMPANIES

WHAT IS A PRE-IPO INVESTMENT?

A 'Pre-IPO Investment', also known as a 'Pre-IPO Placement' occurs when part of an initial public offering (IPO) is placed with private investors just before the IPO is scheduled to hit the market. Private investors in a pre-IPO placement are typically large private equity or hedge funds that are willing to buy a large stake in the company. The size of the investment means the price paid for shares in a pre-IPO placement is usually less than the prospective IPO price. Over the last 10 years, pre-IPO investing has increased the number and frequency of accredited investors participating in pre-IPO placements.

More about Pre-IPOs

Another way to define a pre-IPO placement is the money raised by a company before it goes public. The amount per share is generally discounted from the expected IPO price. There is no real guarantee when the company will go public or the exact price per share will be when it does. These placements occur when there is a high demand for an upcoming IPO. This is because the placement's price per share—and its risk—is contingent on the company eventually going public and its eventual trading volume. The risk arises when the post-IPO demand is lower than expected demand, which decreases the share price. As mentioned above, pre-IPO placements compensate for this risk by offering a discounted price. But if demand causes post-IPO prices to increase, investors would be able to immediately sell the shares at a higher price. To prevent this, a lock-up period is generally attached to the placement. This period prevents these funds from selling the shares in the short-term, attracting more long-term investors.

An Example

Prior to going public in September 2014, Alibaba opened up a pre-IPO placement for large funds and wealthy private investors. As of June 2014, the company was thought to be valued at $150 billion, with demand building for its eventual IPO. Private investors were excited about the chance to invest in the company before it went public. Ozi Amanat, an investor and portfolio manager, purchased a block of $35 million of pre-IPO shares. He allocated the shares among Asian families who had ties to the fund, with each gaining shares valued below $60 per share. When Alibaba went public, demand was even higher than expected, and those who received parts of the $35 million block of stock were rewarded with returns of at least 48%. For Alibaba, this pre-IPO placement mitigated its risk. Even though share prices traded higher on public exchanges, the company ensured it received adequate funding before its IPO.

IP0 vs. PRE-IPO

What are the differences?

ONLY ACCREDITED INVESTORS CAN PARTICIPATE IN PRE-IPO INVESTMENTS

Jan. 31, 2019

The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to educate individual investors about what it means to be an “accredited investor.”

What does it mean to be an accredited investor?

Under the federal securities laws, only persons who are accredited investors may participate in certain securities offerings. One reason these offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss, thus rendering unnecessary the protections that come from a registered offering. Unlike offerings registered with the SEC in which certain information is required to be disclosed, companies and private funds, such as a hedge fund or venture capital fund, engaging in these exempt offerings do not have to make prescribed disclosures to accredited investors. These offerings involve unique risks and you should be aware that you could lose your entire investment.

Who is an accredited investor?

An accredited investor, in the context of a natural person, includes anyone who:

earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

There are other categories of accredited investors, including the following, which may be relevant to you:

any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, or
any entity in which all of the equity owners are accredited investors

In this context, a sophisticated person means the person must have, or the company or private fund offering the securities reasonably believes that this person has, sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.